Fall 2009Session Three ReadingFall 2009 Capital Generation Distribution Recovery Current Approach Available budget drives policy This “supply constrained system” has created Large Work Backlog No Evaluation of Benefits Budgets that do not respond to needFall 2009 General Tax Revenues, Property Assessments Dedicated Tax Revenues (Trust Funds, Enterprise Accounts) Equity Investment Debt Financing (Bonds, Notes, Other I.O.U.’S) Tolls, Usage FeesCurrent Financing MechanismsFall 2009 Turnkey Projects Design-Construction Project Finance Integration Export Credits Materials and Equipment Feasibility Studies Project Finance Consumer Credits User Finance Counter Trade (Barter) Counter purchase (Buy Local Products) Compensation Agreement (Cash and Goods) Buy-Back Transaction (Buy Project Products) Equity Position Build and Operate Joint Ventures Economic RisksCurrent TrendsFall 2009 Sale/Leaseback Arrangements Linkage Payments, Development or impact fees New types of trust funds for public construction (E.G., Public Assets Preservation Trust Fund) Infrastructure banks or revolving fund accounts Innovative Packaging of financing with design/construction services (e.g. B.O.T.)New Financing Mechanisms and Ideas Broadening of scope for activities by public works authorities (e.g. involvement of transit agencies in real estate development; commercial development of air rights) Re-assertion of the private sector role in infrastructure construction and operationFall 2009Since Depression Capital Markets:• were highly fragmented. • Government policies prevented cross boarder investment, • prevented financial intermediaries from operating in different countries,• In the United States, there was not even interstate banking until 1990. For borrowers:• Source of financing was mostly localized, • rate of return on investment reflect local financial condition and capital availability. • As a result the rate of return would vary between similar investments (with similar risk) based on availability of capital in different countries. • For equity investors, P/E ratio was very high in certain countriesStructure of Capital MarketFall 2009Supply of fundsDemand forfundsDemand forfundsrr’K KCountry I Country IIBarrier to Capital FlowMarket SegmentationFall 2009 Financial risks were highly localized and therefore there was not possibility of risk diversification. With a large project it meant huge exposure for lenders.  In the developing countries, international financing was based on sovereign borrowing and the backing was government credit rating. Financing project (development financing) was based on borrowing from international financial institutions and multilateral agencies (such as world bank and regional development banks) by the sovereign country.  Government acted as financial intermediary. In many developing countries these investment were based on political and not effective rate of return.Fall 2009International Financial InstitutionsGovernmentInfrastructureProjectsFund FlowGovernmentInvestmentPayback:Principle and InterestForeign aidImprove in economy and creation of surplus activityFall 2009 Much of flow was from developed countries (to other developed economies or developing economies) There was very little listing of equity in market outside home country. Therefore most of the financing was done through raising debt. The system resulted in accumulation of debt by developing countries in 1980s with increase in possibility of default on their debt. In mid 1990 South East Asian Economics collapsed: Created the first financial crisis since WWIIFall 2009• Washington Consensus• Minimizing role of government• Emphasizing privatization• Liberalization of trade, investment, and capital flow• Deregulation of market• Role of government is macroeconomic stabilization, with emphasis on inflation rather than output and employment• Little emphasis on equity Alternative view:• If markets are not well develop there will be movement toward monopolization• More emphasis on employment, social justice, non-materialistic values (environment)• Impotence of communityWashington Consensus:Washington consensus developed in 1980s as a result of potential default by developing countries after heavy borrowing in 1970s and early 1980s (because of availability of petrodollar and to support )Margaret Thatcher, British P.M. took the leadFall 2009 Justification Efficiency of international capital markets Less terms/controls imposed Government Lending Financial, social and development programs Economic infrastructure Social Infrastructure Budget Support Stabilization Programs Government Agencies Public Utilities Natural Resource Exploration “Key Industry”International Capital MarketsFall 2009 Risks for international lending institutions World debt/creditworthiness Country/Political Risks Riskiness of Construction business Developer if default (equity element) Co-Financing With development banks Commercial banks: short maturities Development banks: long maturities Lower Risks? Syndications Risk DistributionInternational Capital MarketsFall 2009 Risks for international lending institutions World debt/creditworthiness Country/Political Risks Riskiness of Construction business Developer if default (equity element) Co-Financing With development banks Commercial banks: short maturities Development banks: long maturities Lower Risks? Syndications Risk DistributionAreas of Comparative Advantages in International CompetitionFall 2009 When infrastructure supported by broadly based taxes Treat very large number of constituents as “investors” Not all constituents are users of facility Financing is “pay as you go” As a result Taxpayers do not perceive immediately the benefits of their taxes Tax funds may be diverted to other purposes No direct correlation between tax and benefit Once facilities are completed, they are priced essentially as a free good (no capital recovery provision) Thus pricing fails to act as a controlling mechanism with respect to either capacity or demand in public facilities (e.g., highways, transit, water)Pricing Philosophy in Public SectorFall 2009 Predicted upon balancing adequate